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Waiting for a Pullback

Since the S&P 500 index had such a strong rise during the past several trading sessions, it is only natural for traders to consider taking profits and wait for a pullback. The problem is that the pullback may not come. At the time of this writing, Google’s earnings call wowed investors into running the stock up nearly forty dollars after hours. That move alone will normally spill over to the NASDAQ 100 Index moving that measure up around one percent; consequently, all major indexes may closer higher on Friday with many stocks breaking resistance levels. That might mean that the anticipated pullback would not materialize. All too many traders may be caught shaking their heads and saying “coulda, woulda, shoulda.”

What!? They left without me?

This scenario may seem unlikely but it is not uncommon. The range-bound market in the summer of 2010 gave way to a nicely elongated bullish trend, but only after completing a pullback of more than 61% (as measured from SPY’s low on July 1st to its high on August 9th). As it turns out, such a pullback was unusual.

Over the past decade bull markets have begun or resumed on the pattern of an uptrend that scarcely looked back, often making pullbacks of only 20-30% of their recent move up, as the figure below illustrates.

From this oversimplified illustration, you can see that most of the time the S&P 500 index makes an intermediate low, it rises off that low in rapid fashion and doesn’t pullback very often. Perhaps the 2010 market conditions are the most similar to those now.

“A bull market climbs a wall of worry”

Perhaps we are in another leg downward, or at least on our way to a challenge of the 78 percent Fibonacci retracement—but I don’t see it. Many market participants are worrying about a proverbial wall of impossible challenges including domestic government spending and Eurozone uncertainty. For the market to show the kind of support that it has with that much worry floating around, is much more characteristic of a bullish beginning than a bearish finale. Watch for the market’s reaction to next week’s earnings news to signal whether optimism or fear will prevail among investors.

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